Chapter 9
Consolidated Financial
Statements: Income Taxes,
Cash Flows, and Installment
Acquisitions
ACCT 501 (All
examples are from the
textbook by Larsen)
Objectives of the Chapter
1. To learn the accounting treatment of
income taxes for a purchase-type
business combination.
2. To learn the preparation of
consolidated statement of cash flows.
3. To study the accounting for installment
acquisitions of a subsidiary in a
purchase-type business combination.
Income Taxes and Cash Flows
2
Income Taxes in Business
Combinations and Consolidations
The discussion of the accounting for income
taxes in business combinations and
consolidated financial statements are
subdivided in three sections:
a. Income taxes attributable to current fair
values excess of purchased identifiable net
assets;
b. Income taxes attributable to undistributed
earnings of subsidiaries;
c. Income taxes attributable to unrealized and
realized intercompany profits (gains).
Income Taxes and Cash Flows
3
Income Taxes Attributable to Current Fair
Values of Purchased Identifiable Net Assets


When a purchase-type business
combination is qualified as a "tax-free
corporate reorganization" under the IRC,
a new income tax basis (i.e., based on
the current fair value)is Not required for
the combinee's net assets.
In this situation, a temporary difference
may result between provisions for
deprecation and amortization in the
combinee's financial statements and
income tax returns.
Income Taxes and Cash Flows
4
Income Taxes Attributable to Current Fair
Values of Purchased Identifiable Net Assets
(contd.)
The other situation which can also result in
temporary difference is in the pooling-type
business combination, in which there is no
revaluation of combinee's net assets.
When the pooling-type business
combination is not qualified as a "tax free
corporation reorganization" under the IRC,
the income tax basis of the combinee's net
assets may be changed.

Income Taxes and Cash Flows
5
Income Taxes Attributable to Current Fair
Values of Purchased Identifiable Net Assets
(contd.)
In recognition of this problem, the FASB
requires the following:

a deferred tax liability or asset be
recognized in accordance with the
requirements for differences between the
assigned value (i.e., the current value at the
business combination) and the tax bases
(I.e., the carrying amount) of the assets and
liabilities.
Income Taxes and Cash Flows
6
Income Taxes Attributable to Current Fair
Values of Purchased Identifiable Net Assets
(contd.)
Example: assume that the purchasetype business combination of Regal
Corp. and the combinee,Thorne
Company, completed on 6/1/1999, met
the requirements for a "tax-free
corporation reorganization" for income
tax purposes.

Regal paid $800,000 for all of Thornes'
identifiable net assets except cash.
Income Taxes and Cash Flows
7
Income Taxes Attributable to Current Fair
Values of Purchased Identifiable Net Assets
(contd.)
The current fair values of Thorne's
identifiable net assets were equal to their
carrying amounts, except for the
following assets:
Income Taxes and Cash Flows
8
Income Taxes Attributable to Current Fair
Values of Purchased Identifiable Net Assets
(contd.)
Assets
Inventories
Land
Building
Machinery
Totals
Current
Fair
Values
$ 100,000
250,000
640,000
120,000
$1,110,000
Tax/
Bases
Carrying
Amounts
$ 80,000
220,000
500,000
100,000
$900,000
Current Economic
Fair
Life
Values
Excess
$ 20,000
30,000
140,000 20 years
20,000 5 years
$210,000
Income Taxes and Cash Flows
9
Income Taxes Attributable to Current Fair
Values of Purchased Identifiable Net Assets
(contd.)
If the carrying amounts (equal to current
fair values) of Thorne's other identifiable
assets and liabilities were $390,000 and
$650,000, respectively, and the income
tax rate is 40%, Regal's journal entry to
record the business combination with
Thorne Company on 6/1/1999, would be
as follows:
Income Taxes and Cash Flows
10
Income Taxes Attributable to Current Fair
Values of Purchased Identifiable Net Assets
(contd.)
Investment in Net Assetsa
Cash
Inventoriesb
Land
Building
Machinery
Other Identifiable Assets
Goodwill
Deferred Income Tax Lia.
Other Liability
Investment in Net Assets
800,000
800,000
100,000
250,000
640,000
120,000
390,000
34,000
84,000c
650,000
800,000
Income Taxes and Cash Flows
11
Income Taxes Attributable to Current Fair
Values of Purchased Identifiable Net Assets
(contd.)
Notes for the above journal entries:
a. To record acquisition of net assets of
Thorne Company except cash.
b. To allocate cost of Thorne's net assets to
identifiable net assets; to establish liability
for deferred income tax attributable to
differences between current fair values and
tax bases of assets; and to allocate
remainder of cost to goodwill.
c. Current fair value excess of assets *tax
rate =
$210,000Income
*40%
= $84,000
Taxes and Cash Flows
12
Income Taxes Attributable to Current Fair
Values of Purchased Identifiable Net Assets
(contd.)
The deferred income liability ($84,000) will
be extinguished when the temporary
differences reverse through sale or
deprecation.
Example: assume that the inventories were
sold during the year ended 5/31/2000, the
deferred tax liability would be reduced by
$12,400, computed as follows:

Income Taxes and Cash Flows
13
Income Taxes Attributable to Current Fair
Values of Purchased Identifiable Net Assets
(contd.)
Cost of goods sold (inventories current
fair value excess
Building depreciation attributable
to current fair value excess (140,000 / 20)
Machinery depreciation attributable
to current fair value excess ($20,000 / 5)
Total reversing temporary differences
Income tax effect ($31,000 X 0.40)
Income Taxes and Cash Flows
$20,000
7,000
4,000
$31,000
$12,400
14
Income Taxes Attributable to Current Fair
Values of Purchased Identifiable Net Assets
(contd.)
Assuming Regal Corp. had pre-tax financial
income of $420,000 (net of tax-deductible
goodwill amortization of $2,267) for the year
ended May 31, 2000,
and there were no temporary difference
between pre-tax financial income and taxable
income other than those resulting from the
business combination with Thorne Company,
Regal's journal entry for income taxes on
May 31, 2000, is as follows:
Income Taxes and Cash Flows
15
Income Taxes Attributable to Undistributed
Earnings of Subsidiaries
The FASB requires that a deferred income
tax liability be recognized for an excess of
the reported investment income in a
subsidiary over its tax basis(i.e., cash
dividends received from the subsidiary) if this
excess is temporary and will be reverted in
the future.a
Income Taxes and Cash Flows
16
Income Taxes Attributable to Current Fair
Values of Purchased Identifiable Net Assets
(contd.)
Income Taxes Expensec
168,000
Deferred Income Tax Liability
12,400
Income Taxes Payable b 180,400
a. Income tax effect of the temporary difference reversion = >
$31,000 X 0.40 = $12,400.
b.Taxable income x 40% = >($420,000 + $31,000) X 40%
c. $180,400 – $12,400 = $168,000
d. The tax-deductible goodwill amortization expense of $2,267
is included in the measurement of both pre-tax financial
income and taxable income. It is based on the 15-year
amortization period.
Income Taxes and Cash Flows
17
Income Taxes Attributable to Undistributed
Earnings of Subsidiaries (contd.)



Example:
Pinkley Corp. owns 75% of the outstanding
common stock of Seabright Company,
which it acquired for cash on 4/1/1999.
Goodwill acquired by Pinkley in the
purchase-type business combination was
$30,000 and was to be amortized over 15
years.
Seabright's identifiable net assets were
fairly priced at their carrying amounts.
Income Taxes and Cash Flows
18
Income Taxes Attributable to Undistributed
Earnings of Subsidiaries (contd.)



For the year ended 3/1/2000, Pinkley had
pre-tax financial income, exclusive of
goodwill amortization and intercompany
investment income under the equity
method, of $100,000.
Seabright's pre-tax financial income was
$50,000, and dividends declared and paid
by Seabright during fiscal year 2000
totaled $10,000.
The income tax rate for both companies is
40%.
Income Taxes and Cash Flows
19
Income Taxes Attributable to Undistributed
Earnings of Subsidiaries (contd.)




Income tax laws provide for a dividendreceived deduction rate of 80% on
dividends from less-than-80%-owned
domestic corporations.
Neither Pinkley nor Seabright had an
temporary differences.
Neither had any income subject to
preference income tax rates.
There were no intercompany profits
resulting from transactions between
Pinkley and Seabright.
Income Taxes and Cash Flows
20
Income Taxes Attributable to Undistributed
Earnings of Subsidiaries (contd.)
Seabright's journal entry to accrue income
taxes on 3/31/2000 is as follows:
Income Taxes Expense
20,000
Income Taxes Payable
20,000

To record income taxes expense for Fiscal Year 2000 => $50,000 X 40%.
•On 3/31, 2000, Pinkley Corp. prepares the
following journal entries for income taxes
payable, the subsidiary's operating results,
and deferred income tax liability:
Income Taxes and Cash Flows
21
Income Taxes Attributable to Undistributed
Earnings of Subsidiaries (contd.)
Amortization Expense
2,000
Investment in Seabright Cop.
2,000
To record amortization of goodwill for Fiscal Year 2000 ($30,000 / 15 = $2,000)
Income Taxes Expense
39,200
Income Taxes Payable
39,200
To record income taxes expense for Fiscal Year 2000 on income
exclusive of intercompary investment income = > ($100,000 - $2,000)
X 40% = $39,200.
Income Taxes and Cash Flows
22
Income Taxes Attributable to Undistributed
Earnings of Subsidiaries (contd.)
Cash
7,500
Investment in Seabright
7,500
To record div. declared and paid by sub.$10,000 X 0.75 = $7,500
Investment in Seabright 22,500
Intercompany Investment Income
22,500
To accrue share of subsidiary’s net income for Fiscal Year 2000
($30,000* X 0.75 = $22,500) *$50,000 - $20,000 = $30,000
Income Taxes and Cash Flows
23
Income Taxes Attributable to Undistributed
Earnings of Subsidiaries (contd.)
Income Taxes Expense
1,800
Income Taxes Payable
600
Deferred Income Tax Liability
1,200
 To provide for income taxes on
intercompany investment income from
subsidiary as follows:
Income Taxes and Cash Flows
24
Income Taxes Attributable to Undistributed
Earnings of Subsidiaries (contd.)
Net income of subsidiary
$ 30,000
Less: Depre. and amor. attributable
to differences between current fair
values and carrying amounts of
subsidiary’s net assets
0
Income of subsidiary subject to income taxes $30,000
Parent company’s share ($30,000 X 0.75)
$22,500
Less: Dividend-received deduction ($22,500 X 0.80) $18,000
Amount subject to income taxes
$ 4,500
Income taxes expense ($4,500 X 0.40)
$ 1,800
Income Taxes and Cash Flows
25
Income Taxes Attributable to Undistributed
Earnings of Subsidiaries (contd.)
Taxes currently payable based on dividend
received ($7,500 X 0.20 X 0.40 )
$ 600
Taxes deferred until earnings remitted by subsidiary $ 1,200
Income Taxes expense
$ 1,800
Income Taxes and Cash Flows
26
Income Taxes Attributable to Intercompany
Profits (Gains)
The IRC permits an affiliated groupa of
corporation to file a consolidated income tax
return rather than separate returns.
Intercompany profits and losses are
eliminated in a consolidated income tax return
just as they are in consolidated financial
statements.
Income Taxes and Cash Flows
27
Income Taxes Attributable to Intercompany
Profits (Gains) (contd.)
Note a:
An "affiliated group" for tax purposes is
defined as a group of corporations connected
through stock ownership with a common
parent corp. which owns directly at least 80%
of the voting power of all subsidiaries and at
least 80% of each class of the nonvoting stock
of at least one of the other affiliates.
Income Taxes and Cash Flows
28
Income Taxes Attributable to
Intercompany Profits (Gains) (contd.)
If a parent company and its subsidiaries do
not qualify for the "affiliated group" status,
or if they elect to file separate tax returns,
the provisions of SFAS No. 109,
"Accounting for Income Taxes" for the
recognition of deferred tax assets and
liabilities will be applied.
Income Taxes and Cash Flows
29
Income Taxes Attributable to
Intercompany Profits in Inventory
For unrealized intercompany profits in
inventory at the end of the first year for
an affiliated group's operation, return to
the working paper elimination on page
354 of the textbook for Post Corp. and
Sage Company (a 95% partially owned
subsidiary of Post) on 12/31/2001, which
is as follows:
Income Taxes and Cash Flows
30
Income Taxes Attributable to
Intercompany Profits in Inventory
(contd.)
Intercomany Sales—Sage 120,000
Intercompany CGS—Sage 96,000
CGS—Post
16,000
Inventories—Post
8,000
To eliminate intercompany sales, cost of goods sold
(CGS), and unrealized intercomany profit in
inventories
Income Taxes and Cash Flows
31
Income Taxes Attributable to Intercompany
Profits in Inventory (contd.)
If Post and Sage file separate income tax
returns for year 2001, the following additional
working paper elimination is required on
12/31/2001:
Deferred Income Tax Asset—Sage 3,200
Income Taxes Expense—Sage
3,200
To defer income taxes provided on separate income tax returns
of subsidiary applicable to unrealized intercompany profits in
parent company’s inventories on Dec. 31, 2001 ($8,000 X 0.40 =
$3,200)
Income Taxes and Cash Flows
32
Income Taxes Attributable to Intercompany
Profits in Inventory (contd.)
Note: the $3,200 reduction in income tax
expense should be considered in the
computation for the minority interest in net
income of the subsidiary for the year ended
12/31/2001.
For the unrealized intercompany profits in
beginning and ending inventories, return to the
working paper elimination on p356 of the
textbook for the year ended 12/31/2002, which
follows:
Income Taxes and Cash Flows
33
Income Taxes Attributable to Intercompany
Profits in Inventory (contd.)
Retained Earnings—Sagea
7,600
Minority Interest in NA of Sub.
400
Intercompary Sales—Sage 150,000
Intercompany CGS—Sage
120,000
CGS—Post
26,000
Inventories—Post
12,000
a. $8,000X0.95
To eliminate intercompany sales, cost of goods sold, and
unrealized intercompany profit in inventories.
Income Taxes and Cash Flows
34
Income Taxes Attributable to
Intercompany Profits in Inventory
(contd.)
If the affiliated group file income separately,
the following additional working paper
eliminations are required on 12/31/2002:
Deferred Income Tax Asset—Sage 4,800
Income Taxes Expense—Sage
4,800
To defer income taxes provided on separate income tax
returns of subsidiary applicable to unrealized
intercompany profits in parent company’s inventories
on Dec. 31, 2002 ($12,000X0.40=$4,800).
Income Taxes and Cash Flows
35
Income Taxes Attributable to
Intercompany Profits in Inventory
(contd.)
Income Taxes Expense—Sage 3,200
Retained Earning—Sage a
3,040
Minority Interest in Net Assetsb&c
160
To provide for income taxes attributable to realized intercompany
profits in parent company’s inventories on Dec. 31, 2001.
($8,000X0.40=$3,200)
a. $3,200X0.95; or $7,600X0.40.
b. $3,200X0.05; or $400X0.40.
c. This elimination reflects the income tax effects of the
realization by the consolidated group, on a FIFO
basis,of the intercompnay profits in the parent
company's beginning inventories.
Income Taxes and Cash Flows
36
Income Taxes Attributable to
Intercompany Profits in Inventory
(contd.)
Note to the working paper elimination of year
2002:
The decrease on the subsidiary's I/T expense
of $4,800 and the increase on subsidiary's the
I/T expense of $3,200 are included in the
computation of the minority interest in
subsidiary's net income.
Income Taxes and Cash Flows
37
Income Taxes Attributable to Unrealized
Intercompany Gain in Land
Return to the working paper elimination on p65
of chapter 8 notes for the intercompany gain
resulting from an intercompany sale of land by
the parent company on 12/31/2001(Post):
Intercompany Gain on
Sale of Land—Post
50,000
Land—Sage
50,000
To eliminate unrealized intercompany gain on sale of land.
Income Taxes and Cash Flows
38
Income Taxes Attributable to
Unrealized Intercompany Gain in
Land(contd.)
Assuming a 40% income tax, the following
working paper elimination is needed if Post
and Sage filed separate income tax returns for
year the year ended 12/31/2001:
Deferred Income Tax Asset—Post 20,000
Income Taxes Expense—Posta 20,000
a. This decrease in the expense has no impact on the
minority interest in subsidiary's net income.
Income Taxes and Cash Flows
39
Income Taxes Attributable to Unrealized
Intercompany Gain in Land(contd.)
The purposes of the working paper elimination
on 12/31/01:
To defer income taxes provided on separate
income tax returns of parent company
applicable to unrealized intercompany gain in
subsidiary's land on Dec. 31, 2001
($50,000X0.04=$20,000).
Income Taxes and Cash Flows
40
Income Taxes Attributable to Unrealized
Intercompany Gain in Land(contd.)

The following working paper elimination
applies to all subsequent years for this
intercompany sale of land as long as
Sage does not sell the land to an
outsider:
Retained Earnings—Post
Land—Sage
50,000
50,000
To eliminate unrealized intercompany
gain in land.
Income Taxes and Cash Flows
41
Income Taxes Attributable to
Unrealized Intercompany Gain in
Land(contd.)
In years subsequent to year 2001, as long as
the subsidiary owns the land, the following tax
related working paper elimination is also
required at the end of the year:
Deferred Income Tax Asset—Post 20,000
Retained Earnings—post
20,000
To defer income taxes attributable to unrealized intercompany gain in
subsidiary’s land ($50,000x 40%).
This elimination has no impact on the minority
interest in subsidiary's net income.
Income Taxes and Cash Flows
42
Income Taxes Attributable to
Unrealized Intercompany Gain in
Land(contd.)
When Sage sold the land, the following
elimination would be prepareda:
Income Tax Expense-Postb 20,000
Retained Earnings- Post
20,000
a. This is due to the intercompany gain is realized by
Sage on behave of Post
b. No impact on the minority interest in subsidiary's net
income
Income Taxes and Cash Flows
43
Income Taxes Attributable to Unrealized
Intercompany Gain in a Depreciable Plant
Assets
Return to the working paper elimination on p76
of chapter 8 note for illustration:
12/31/2001
Intercompany Gain on
Sale of Machinery—Sage 23,800
Machinery—Post
23,800
To eliminate unrealized intercompany gain of $23,800 on sale of
Post's machinery to Sage on 12/31/3001.
This intercompany gain will be realized
through the periodic depreciation of the asset.
Income Taxes and Cash Flows
44
Income Taxes Attributable to Unrealized
Intercompany Gain in a Depreciable Plant
Assets (contd.)
 Assuming separate income tax (I/T) returns
and an I/T tax rate of 40%, the following
additional working paper elimination is
required on 12/31/2001:
 Deferred I/T Asset—Sage 9,520
I/T Expense—Sage a
9,520
To defer income taxes provided on separate
income tax returns of subsidiary applicable to
unrealized intercompany gain in parent company’s
machinery on Dec. 31, 2001 (23,800X0.40=$9,520).
Income Taxes and Cash Flows
45
Income Taxes Attributable to Unrealized
Intercompany Gain in a Depreciable Plant
Assets (contd.)
a. The $9,520 increase in the Sage's net
income should be included in the
computation of minority interest in the
subsidiary's net income for year 2001.
 For the year ended 12/31/2002, the working
paper elimination of the intercompany gain is
as follows:
Income Taxes and Cash Flows
46
Income Taxes Attributable to Unrealized
Intercompany Gain in a Depreciable Plant
Assets (contd.)
12/31/2002
Retained Earning—Sagea
Minority Interest in Net
Assets of Subsidiaryb
Accu. Depre.—Post
Machinery—Post
Depre. Expense—Post
22,610
1,190
4,760
23,800
4,760
a. $23,800X0.95 b.$23,800X0.05
To eliminate unrealized intercompary gain in machinery and in
related depreciation. Gain element in depreciation company is
23,800X0.20=$4,760 based on
five-year
economic
life.
Income Taxes and Cash Flows
47
Income Taxes Attributable to
Unrealized Intercompany Gain in a
Depreciable Plant Assets (contd.)
 The elimination for income taxes
attributable to the intercompany gain for the
year ended 12/31/2002 is as follows:
I/T Expense—Sagea
1,904
Deferred I/T Asset—Sageb 7,616
Retained Earning—Sagec
9,044
Minority Interest in NA of Sub.d
476
a.$4,760 x 40% b. 9,520-$1,904
c.$9,520X0.95; or $22,610X40%
d. $9,520X0.05; or $1,190X40%
Income Taxes and Cash Flows
48
Income Taxes Attributable to
Unrealized Intercompany Gain in a
Depreciable Plant Assets (contd.)
 The purposes of the above working paper
elimination are:
1. To provide income taxes expense on
intercompany gain realized through parent
company’s depreciation (4,760X0.40=$1,904);
2. To defer income taxes attributable to the
remainder of unrealized gain.
Income Taxes and Cash Flows
49
Income Taxes Attributable to Unrealized
Intercompany Gain in a Depreciable Plant
Assets (contd.)
 Comments to the above working paper
elimination:
1. The decrease in the subsidiary's net
income is included in the computation of
the minority interest in the subsidiary's net
income for year 2002.
2. Comparable working paper eliminations to
the above elimination are necessary on
December 31, years 2003, 2004,2005 and
2006.
Income Taxes and Cash Flows
50
Income Taxes Attributable to Intercompany
Gain on Extinguishment of Bonds
Return to the 12/31/2001 working paper
elimination on p131 of Chapter 8 notes for
illustration:
Intercompany Bonds Payable—
Sage
Discount on Intercompany
Bonds Payable-Sage
Investment in Sage
Company Bonds-Post
Gain on Extinguishment of
Bonds-Sage
300,000
18,224
257,175
24,601
To eliminate subsidiary’s bonds acquired by parent
and to recognize gain on the extinguishment of the
bonds.(Income tax effects are disregarded.)
Income Taxes and Cash Flows
51
Income Taxes Attributable to Intercompany
Gain on Extinguishment of Bonds (contd.)
 The following working paper elimination is
required on 12/31/2001 to accompany the
above working paper elimination assuming a
separate income tax return filing, a 40%
income tax rate and the gain on
extinguishment of debt is not material:
Income Taxes Expense –Sage a
9,840
Deferred Income Tax Lia.-Sage
9,840
To provide for income taxes attributable to subsidiary's realized gain on parent
company's acquisition of the subsidiary's bonds ($24,601*40%)
Income Taxes and Cash Flows
52
Income Taxes Attributable to Intercompany
Gain on Extinguishment of Bonds (contd.)
 The purpose of the elimination on
12/31/2001:
To provide for income taxes attributable to
subsidiary's realized gain on parent
company's acquisition of the subsidiary's
bonds ($24,601*40%).
Income Taxes and Cash Flows
53
Income Taxes Attributable to Intercompany
Gain on Extinguishment of Bonds (contd.)

Note to the elimination on 12/31/2001:
The increase in expense of the subsidiary
($9,840) in the above elimination should
be included in the computation of the
minority interest in net income of the
subsidiary for year 2001.
Income Taxes and Cash Flows
54
Income Taxes Attributable to Intercompany
Gain on Extinguishment of Bonds (contd.)

The working paper elimination for the bonds
and interest on 12/31/2002 is as follows:
Intercompany Interest Revenue-Post
Intercompany Bonds Payable-Sage
Discount on Intercompany Bonds PayableSage
Investment in Sage Company Bonds- Post
Intercompany Interest Expense-Sage
Retained Earnings-Sage($24,601 x 0.95)
Minority Interest in Net Assets of Subsidiary
38,576
300,000
14,411
265,751
33,813
23,371
1,230
To eliminate subsidiary’s bonds owned by parent company, and
related interest revenue and expense; and to increase subsidiary’s
beginning retained earnings by amount of unamortized realized
gain on the extinguishments of the bonds.
Income Taxes and Cash Flows
55
Income Taxes Attributable to Intercompany
Gain on Extinguishment of Bonds (contd.)
 The following I/T related working paper elimination
is necessary to accompany the above elimination:
 12/31/02
Retained Earnings – Sagea
9,348
Minority Interest in NA of Sub.b
492
I/T Expense – Sage c
1,905
Deferred I/T Lia.d
7,935
a. $9,840x 0.95 or $23,371 x 40%
b. $9,840x 0.05
c. $38,576-$33,813) x 40%
d. $9,840-$1,905
Income Taxes and Cash Flows
56
Income Taxes Attributable to Intercompany
Gain on Extinguishment of Bonds (contd.)
The purposes of the I/T related working paper
elimination prepared on 12/31/02:
1. To reduce the subsidiary’s income taxes
expense for amount attributable to recorded
intercompany gain (for consolidation
purposes) on subsidiary’s bond;
2. To provide for remaining deferred income
taxes on unrecorded portion of gain.
Income Taxes and Cash Flows
57
Income Taxes Attributable to Intercompany
Gain on Extinguishment of Bonds (contd.)
 Note to the I/T related working paper
elimination on 12/31/2002:
 The $1,905 decrease in expense (increase
in the subsidiary's net income is included in
the computation of the minority interest in
the subsidiary's net income for the year
ended 12/31/2002
Income Taxes and Cash Flows
58
Summary: Income Taxes Attributable to
Intercompany Profits (Gains)
The unrealized intercompany profits (gains)
resulting from intercompany transactions of
affiliated companies required interperiod tax
allocation when the affiliated companies file
separate income tax returns.
The elimination of unrealized intercompany
profits causes a temporary difference.

Income Taxes and Cash Flows
59
Summary: Income Taxes Attributable to
Intercompany Profits (Gains)-contd.
The elimination of unrealized intercompany
gains for consolidation purposes will result in a
taxable income exceeding a pre-tax financial
income.
Thus, a deferred income tax assets must be
accounted for in the working paper
eliminations that accompany the profit (gain)
eliminations.

Income Taxes and Cash Flows
60
Summary: Income Taxes Attributable to
Intercompany Profits (Gains)- contd.
In the case of intercompany bonds, pre-tax
financial income exceeds taxable income of
the accounting period of the realized gain.
Thus, a deferred income tax liability must be
provided in a working paper elimination.

Income Taxes and Cash Flows
61
Summary: Income Taxes Attributable to
Intercompany Profits (Gains) – contd.
The following pages summarize the
working paper eliminations for the
intercompany transactions on inventory,
land, depreciable plant assets and
extinguishment of bonds for the year ended
12/31/2002.

Income Taxes and Cash Flows
62
Summary: Income Taxes Attributable to
Intercompany Profits (Gains) – Inventory
b)
POST CORPORATION AND SUBSIDIARY
Partial Working Paper Eliminations
December 31, 2002
Retained Earnings—Sage
7,600
Minority Interest in NA of Sub.
Intercompany Sale—Sage
400
150,000
Intercompany CGS-Sage
120,000
CGS—Post
26,000
Inventories—Post
12,000
To eliminate intercompany sales, cost of goods, and
unrealized intercompany profits in inventories.
Income Taxes and Cash Flows
63
Summary: Income Taxes Attributable to
Intercompany Profits (Gains) –Inventory
c) Deferred Income Tax Asset-Sage
Income Taxes Expense-Sage
4,800
4,800
To defer income taxes provided on separate income
tax returns of subsidiary applicable to unrealized
intercompany profits in parent company’s inventories
on Dec. 31, 2002 ($12,000X0.40=$4,800).
Income Taxes and Cash Flows
64
Summary: Income Taxes Attributable to
Intercompany Profits (Gains)-Inventory
c) Income Taxes Expense—Sage
3,200
Retained Earnings—Sage
($3,200X0.95; or $7,600X0.40)
Minority interest in Net Assets
of Subsidiary($3,200X0.05; or
$400X0.40)
4,800
160
To provide for income taxes attributable to realized
intercompany profits parent company’s inventories
on Dec. 31, 2001($8,000X0.40=$3,200).
Income Taxes and Cash Flows
65
Summary: Income Taxes Attributable to
Intercompany Profits (Gains)-Land
d) Retained Earning—Post
Land--Sage
500,000
500,000
To eliminate unrealized intercompany
in land.
e) Deferred Income Tax Asset–
Post
Retained Earnings--post
20,000
20,000
To defer income taxes attributable to
unrealized intercompany gain in subsidiary’s
land ($50,000X0.40=$20,000).
Income Taxes and Cash Flows
66
Summary: Income Taxes Attributable to
Intercompany Profits (Gains)-Plant Assets
f) Retained Earning—Sage
($23,800X0.95)
Minority Interest in Net Assets
of Subsidiary ($23,800X0.05)
Accumulated Depreciation—
Post
Machinery—Post
Depreciation Expense—Post
22,610
1,190
4,760
23,800
4,760
To eliminate unrealized intercompany gain in machinery
and in related depreciation. Gain element in depreciation
computed as $23,800X0.20=$4,760, based on five-year
economic life.
Income Taxes and Cash Flows
67
Summary: Income Taxes Attributable to
Intercompany Profits (Gains)-Plant Assets
g) Income Taxes Expense--Sage
1,904
Deferred Income Tax Asset—
7,616
Sage ($9,520-$1,904)
Retained Earnings—Sage
($9,520X0.95; or $22,610X0.40)
Minority Interest in Net Assets
of Subsidiary ($9,520X0.05; or
$1,190X0.40)
9,044
476
To provide for income taxes expense on intercompany
gain realized through parent company’s depreciation
($4,760X0.40=$1,904); and to defer income taxes
attributable to remainderIncome
of unrealized
gain.
Taxes and Cash Flows
68
Summary: Income Taxes Attributable to
Intercompany Profits (Gains)-Bonds
h) Intercompany Interest Revenue—Post
Intercompany Bond Payable—Sage
Discount on Intercompany B/P-Sage
Invest. in Sage Company -Post
Intercompany Interest Expense--Sage
Retained Earnings—Sage ($24,601X0.95)
Minority Interest in NA of Sub.
38,576
300,000
14,411
265,751
33,813
23,371
1,230
To eliminate subsidiary’s bonds owned by parent company, and
related interest revenue and expense; and to increase subsidiary’s
beginning retained earning by amount of unamortized realized gain
on the extinguishment of the bond.
Income Taxes and Cash Flows
69
Summary: Income Taxes Attributable to
Intercompany Profits (Gains)-Bonds
i) Retained Earning—Sage
9,348
($9,840X0.95; or $23,371X0.40)
Minority interest in Net Assets of
492
Subsidiary ($9,840X0.05; or
$1,230X0.40)
Income Taxes Expense—Sage
1,905
[($38,576-$33,813)X0.40]
Deferred Income Tax Liability–
7,935
Sage ($9,840-$1,905)
To reduce the subsidiary’s income taxes expense for amount
attributable to recorded intercompany gain (for consolidation
purposes) on subsidiary’s bonds; and to provide for remaining
deferred income taxes on unrecorded
portion
Income Taxes and
Cash Flowsof gain
70
Summary: Income Taxes Attributable to
Intercompany Profits (Gains)-Comments
All the forgoing eliminations except
(d) and (e) affect the net income of
Sage Company.
The corresponding amount of those
eliminations are included in the
computation of minority interest in net
income of subsidiary for year 2002

Income Taxes and Cash Flows
71
Consolidated Statement of Cash
Flows – General Comments
The consolidated statement of cash flows is
prepared as described in intermediate
accounting textbooks with a few points
deserves special attention:
 The depreciation and amortization expense
added (when using the indirect method) to
total consolidated income is the consolidated
deprecation and amortization expense.
Income Taxes and Cash Flows
72
Consolidated Statement of Cash
Flows-General Comments (contd.)
The minority interest in net income of
subsidiary (an expense on the consolidated
income statement) should also be added to
the consolidated net income in preparing the
net cash flows of the operating activities.
Only cash dividends paid by the parent
company and cash dividends paid by partially
owned subsidiary to minority stockholders are
reported as cash flows from financing
activities.

Income Taxes and Cash Flows
73
Consolidated Statement of Cash
Flows – General Comments(contd.)
A cash acquisition by the parent company of
additional shares of common directly from a
subsidiary has no impact on the consolidated
cash flows and is not reported in a
consolidated statement of cash flows.
A cash acquisition by the parent company of
additional shares of common directly from
minority stockholders reduces consolidated
cash and is reported in a consolidated
statement of cash flows as an investing
activity.

Income Taxes and Cash Flows
74
Consolidated Statement of Cash
Flows – General Comments(contd.)
A cash acquisition by the parent company of
additional shares of common directly from a
subsidiary has no impact on the consolidated
cash flows and is not reported in a
consolidated statement of cash flows.
A cash acquisition by the parent company of
additional shares of common directly from
minority stockholders reduces consolidated
cash and is reported in a consolidated
statement of cash flows as an investing
activity.

Income Taxes and Cash Flows
75
Illustration of Consolidated Statement
of Cash Flows

Example:
Parent Corp. owned 100% of Sub Company
for a few years through a purchase-type
business combination. Sub has one class of
common stock and its total stockholder's
equity on 12/31/99 was $500,000.
On 1/2/2000, parent sold 30% of its
investment in Sub's common stock to
outsiders for $205,000, which was $55,000
more than the carrying amount of the
investment in Parent's records.

Income Taxes and Cash Flows
76
Illustration of Consolidated Statement
of Cash Flows (contd.)
Sub had a net income of $100,000 for Year 2000
and paid cash dividends of $60,000 during Year
2000.
During Year 2000, Parent issued additional common
stock and cash of $290,000 for plant assets which a
current fair value of $490,000.
The consolidated entity had additional long-term
borrowings of $93,000 during Year 2000, and interest
payments totaled $62,000 (none was capitalized).
Income tax payments totaled $234,000.

Income Taxes and Cash Flows
77
Illustration of Consolidated Statement
of Cash Flows (contd.)
The followings are the consolidated
income statement for Year 2000, the
consolidated statement of stockholder's
equity for Year 2000, and the comparative
consolidated balance sheets on
December 31, 1999 and 2000:

Income Taxes and Cash Flows
78
Consolidated Income statement for the
Year ended 12/31/2000
Sales and other revenue (including gain of
$55,000 on sale of investment in Sub Company
common stock)
Costs and expenses:
Costs of goods sold
Depreciation and amortization expense
Other operating expenses
Income before income taxes
Income taxes expense
Total consolidated income
Less: Minority interest in net income of
subsidiary
Net income
Basic earnings per share of common stock
$2,450,000
1,500,000
210,000
190,000
Income Taxes and Cash Flows
190,000
$550,000
250,000
$300,000
30,000
$270,000
$5.14
79
Consolidated Statement of Stockholders'
Equity For Year Ended 12/31/2000
Common Additional
Stock, $10 Paid-in
Par
Capital
Balances, beginning of $500,000 $ 300,00
year
Issuance of 5,000
50,000
150,000
shares of common
stock for plant assets
Net income
Cash dividends
declared and
paid($2.91 a share)
Balances, end of year
$ 550,000 $ 450,000
Retained
Earnings
$ 670,000
Total
$1,470,000
200,000
270,000
270,000
(160,000)
(160,000)
$ 780,000
$ 1,780,000
Income Taxes and Cash Flows
80
Consolidated Balance Sheets
December 31,
2000
1999
Assets
Cash
Other current assets
Plant assets
Less: Accumulated
depreciation of plant asset
Intangible assets (net)
Total assets
$ 300,000 $ 240,000
900,000
660,000
3,000,000 2,510,000
(1,300,000) (1,100,000)
240,000
250,000
$3,140,000 $2,560,000
Income Taxes and Cash Flows
81
Consolidated Balance Sheets(contd.)
December 31,
2000
1999
Liabilities & Stockholder’s Equity
Current liabilities
Long-term debt
Minority interest in net assets of
subsidiary
Common stock, $10 per
Additional paid-in capital
Retained Earnings
Total Lia. & stockholders' equity
505,000
693,000
162,000
490,000
600,000
550,000
500,000
450,000
300,000
780,000
670,000
$3,140,000 $2,560,000
Income Taxes and Cash Flows
82
Working Paper for Consolidated Statement of
Cash Flows for Year Ended 12/31/2000 (indirect
Method)
Balances
12/31/99
Cash
Other current assets
less current liabilities
Plant assets
Intangible assets (net)
Totals
Transactions for Year
2000
Debit
240,000 (x) 60,000
170,000 (5) 225,000
Credit
300,000
395,000
2,510,000 (6) 290,000
(9) 200,000
250,000
3,170,000
Balances
12/31/00
3,000,000
(2) 10,000
Income Taxes and Cash Flows
240,000
3,935,000
83
Working Paper for Consolidated Statement of
Cash Flows for Year Ended 12/31/2000 (indirect
Method) (contd.)
Balances
12/31/99
Transactions for Year Balances
2000
12/31/00
Debit
Accumulated depreciation 1,100,000
Long-term debt
600,000
Minority interest in net
assets of subsidiary
Common stock, $10 par
Additional paid-in capital
Retained earnings
Totals
500,000
300,000
670,000
3,170,000
Credit
(2)200,000 1,300,000
(7) 93,000
693,000
(8) 18,000 (3) 30,000
162,000
(4)150,000
(9) 50,000
550,000
(9)150,000
450,000
(8)160,000 (1)270,000
780,000
953,000
953,000 3,935,000
Income Taxes and Cash Flows
84
Working Paper for Consolidated Statement of
Cash Flows for Year Ended 12/31/2000 (indirect
Method) (contd.)
Balances Transactions for Year Balances
12/31/99
2000
12/31/00
Operating Activities
Net Income
Add: Depreciation and
amortization expense
Minority interest in
net income of
subsidiary
Less: Gain on sale of
investment in Sub
Company common
stock
Net increase in net
current assets
Debit
(1)270,000
(2)210,000
Credit
From
operating
activities
$230,000
(3) 30,000
(4) 55,000
(5)225,000
Income Taxes and Cash Flows
85
Working Paper for Consolidated Statement of
Cash Flows for Year Ended 12/31/2000 (indirect
Method) (contd.)
Balances Transactions for Year Balances
12/31/99
2000
12/31/00
Investing Activities
Sale of investment in Sub
Company common
Acquisition of plant assets
Debit
(4)205,000
Credit
From
investing
(6)290,000 activities
($85,000)
Income Taxes and Cash Flows
86
Working Paper for Consolidated Statement of
Cash Flows for Year Ended 12/31/2000 (indirect
Method) (contd.)
Balances Transactions for Year Balances
12/31/99
2000
12/31/00
Financing Activities
Long-term borrowings
Payable of dividends,
including $18,000 to
minority stockholders
of Sub company
Subtotals
Increase in cash
Totals
Debit
(7) 93,000
Credit
From
financing
(8)178,000 activities
($85,000)
808,000
748,000
(x) 60,000
808,000
808,000
Income Taxes and Cash Flows
87
Consolidated Statement of Cash Flows
for Year Ended 12/31/2000
Net cash provided by operating activities (Exhibit 1)
Cash Flows from Investing Activities:
Disposal of investment in Sub Company
common stock
Acquisition of plant assets
Net cash used in investing activities
Cash Flows from Financing Activities:
Long-term borrowings
Dividends paid including $18,000 to minority
stockholders of Sub Company
$230,000
$205,000
(290,000)
(85,000)
$ 93,000
(178,000)
Net cash used in financing activities
Net increase in cash
Cash, Beginning of year
Cash, end of year
Income Taxes and Cash Flows
(85,000)
$60,000
240,000
$300,000
88
Consolidated Statement of Cash Flows
for Year Ended 12/31/2000 (contd.)
EXHIBIT 1 Cash flows from operating activities:
Net income
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization expense
Minority interest in net income of subsidiary
Gain on disposal of investment in Sub
Company common stock
Net increase in net current assets (240,000-15,000)
Net cash provided by operating activities
Income Taxes and Cash Flows
$270,000
210,000
30,000
(55,000)
(225,000)*
$230,000
89
Consolidated Statement of Cash Flows
for Year Ended 12/31/2000 (contd.)
EXHIBIT 2 Supplemental disclosure of
cash flow information:
Cash paid during the year for:
Interest (none capitalized)
Income taxes
EXHIBIT 3 Noncash investing and
financing activities:
Common stock issues for plant
assets
Income Taxes and Cash Flows
$ 62,000
234,000
$200,000
90
Notes to the Above Consolidated
Statement of Cash Flows
1. Net cash provided by operating activities
includes the minority interest in net income
of Sub Company.
2. Net cash provided by operating activities
excludes the gain of $55,000 from sale of
the 30% of investment in Sub company.
The proceeds received, $205,000, are
reported as as a component of investing
activity.
Income Taxes and Cash Flows
91
Notes to the Above Consolidated
Statement of Cash Flows
3. Only the dividends paid to stockholders of
the Parent Corp ($160,000) and to minority
stockholders of Sub Company ($18,000,
Not, $60,000) are reported as cash flows
from financing activities.
4. The issuance of common stock by Parent
to acquire plant assets is a noncash
transaction (a direct exchange).
Income Taxes and Cash Flows
92